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  Assessment and recommendations
  The Swedish economy has recovered strongly in recent years with annual GDP growth expected to exceed 4% in 2006. This recovery has come sooner and been stronger than in most other European countries, illustrating the relative soundness of the Swedish economy. Inflation expectations are well anchored. This successful performance is a result of the way in which Sweden responded to the deep crisis in the early 1990s, when it greatly improved its macro policy framework. With a structural budget surplus of around 2% of GDP, Sweden is preparing itself to meet future demographic challenges much better than most OECD countries. All parts of society benefit from this forward-looking policy framework. For those employed, real wage growth has averaged 3½ per cent since 1998 when a new stability-oriented wage formation framework was introduced, compared to just 2½ per cent during the inflationary 1970s and 1980s.
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  Key challenges for the Swedish economy
  Sweden enjoys excellent macroeconomic performance with high rates of growth and stable inflation expectations. However, tensions are visible at the margin. Joblessness is widespread among immigrants and youngsters, and disability and sickness rates are comparatively high. Combating exclusion both in the labour and housing markets is a key challenge for policymakers. Early steps in regulatory reform, taken in the 1990s are paying off in terms of productivity and GDP, but renewed regulatory reform is needed inter alia to address the low rate of business formation. Progress on this reform agenda – employment in particular – is vital also for the long-run fiscal outlook which is shaped by population ageing. This chapter identifies such key challenges after first assessing recent macroeconomic developments including the housing and construction boom.
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  Why has inflation been persistently low?
  Average inflation in Sweden has been one of the lowest among European countries since the mid-1990s. Three supply-side factors help to explain this phenomenon, all related in some sense to increased global integration. First, a shift towards imports from low-cost producing countries has resulted in falling import prices. Second, deregulation and increased product market competition with foreign companies entering the market has led to price falls in some sectors, notably in retailing. Third, wage growth has lagged productivity and kept unit labour costs down. This chapter reviews these factors and analyzes the policy options for the central bank.
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  Making employment inclusive – for immigrants and natives alike
  Swedish employment rates of prime-age men and women have not recovered to the level they were at before the deep crisis in the early 1990s. This is problematic because labour supply is crucial for long-run fiscal sustainability and because lower employment rates partly reflect involuntary exclusion generated by factors like taxes, benefits, labour-market institutions and attitudes. Policy reform is therefore needed. This chapter first assesses the ambitious initiatives concerning unemployment benefits, employers’ contribution rebates and in-work tax credits introduced from 2007. It then focuses on immigrants: some come from deprived backgrounds with limited skills while others are highly trained. Better integrating this wide diversity on the Swedish labour market is a key challenge. It requires attention to wage flexibility as well as employment protection rules that make it risky for firms to hire immigrants whose capabilities are often difficult to gauge. Finally, progress on reducing sickness absence is reviewed.
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  The housing market – better allocation via less regulation
  While several sectors in the economy have been deregulated, the Swedish housing market remains distorted, hindering an optimal matching of supply and demand. In the rental market the rent setting framework with its focus on cost-based rents in the public sector prevents a price response, leading to long queues in some regions and vacancies in others. Many Swedes that would have preferred otherwise are driven into the owner-occupied segment, where prices are increasing strongly, and rising above an estimated fundamental value. The supply of new dwellings is made more difficult by an uncompetitive construction industry, coupled with cumbersome planning regulations and few incentives for municipalities to issue more land. On the fiscal side, real estate taxes are below neutral levels, implying an indirect subsidy to housing. This chapter presents a critical review of the recent steps to abolish real estate taxes and also proposes comprehensive reform of regulations in the rental housing sector.
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